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AUTOMOTIVE NEWS EUROPE'S 2008 GUIDE TO PURCHASING

Purchasing execs to suppliers: Costs must fall

To cut prices, automakers will start cooperating earlier with their component makers

For plants outside of Europe -- such as the Logan factory in Pitesti, Romania -- Renault’s target for low-cost country sourcing is 80%. Renault subsidiary Dacia currently sources 65% of its parts from low-cost Romania.
Automaker purchasing bosses are concerned about the health of their suppliers, but they refuse to take blame for the financial problems many partsmakers have faced. That is one of the opinions five top executives shared with Automotive News Europe Correspondents Edmund Chew and Stewart Pedder.

The five executives -- Ford of Europe’s Birgit Behrendt, Renault’s Odile Desforges, Fiat group’s Gianni Coda, Mercedes-Benz’s Frank W. Deiss and Toyota Europe’s Mark Adams -- also talked about their strategies for increasing sourcing from low-cost countries and how they aim to quicken the introduction of new technologies in future models.

Strategies for saving
Ways that automakers are reducing purchasing costs
-- Involving suppliers earlier
-- Advising suppliers on how to boost productivity
-- Using more cost-effective designs
-- Using more modules

Are there still big cost savings to come from purchasing? If so, where and how?

Behrendt: The early involvement of suppliers in the product development process is key as most of the cost is defined then. Utilizing new technologies can also lead to significantly lower costs.

Desforges: Renault’s objective is to save 14 percent on purchasing at the end of 2009 compared with 2006.

To sustain a regular pace, the key idea is to work with suppliers on action plans. In other words, we help them cut costs by boosting their productivity through improvements of their own purchasing strategy, increased sourcing from low-cost countries and technical cost reductions. Cutting costs is not our sole objective. We want quality and delivery lead time to improve.

Deiss: The track record of our latest efficiency program, called CORE, clearly shows that an important part of increasing return on sales can be realized by optimizing material costs.

Following CORE, we now expect further gains from purchasing practices due to Mercedes’ new modular car design. To give you an idea, Mercedes will implement about 100 newly defined modules -- a key criteria for further variable cost improvements that will be realized over the next few years.

Adams: If we just try to put price pressure on the suppliers that may not be sustainable. Therefore, we should lead with more cost-effective designs and more cost-effective manufacturing processes.

“The early involvement of suppliers in the product development process is key,” said Birgit Behrendt, Ford of Europe vice president of purchasing.
How worried are you about the financial health of the supply base? What can you do to stop it from causing problems for your operations?

Behrendt: We monitor our suppliers using both financial as well as non-financial information. Should a difficult situation arise, it is important to work closely with all affected parties to find an acceptable solution.

Desforges: A risk committee is responsible for following the financial situation of our suppliers that are facing difficulties and piloting action plans [for them]. More than half of our suppliers post an operating margin that exceeds 3 percent. Those that have a lower operating margin are generally either in too diverse a sector or unable to adapt to the evolution of the automotive industry. Generally, those that are in a bad shape financial have quality problems too. In any case, suppliers are responsible for taking the management decisions to solve their problems. If they fail, Renault’s output could face difficulties. That is why we would consider ending our business relations with such suppliers.

Coda: We have a structured procedure to assess our suppliers’ financial health. Using this procedure, we also prevent companies that are in financial trouble from being assigned a supply contract. Potential suppliers can come back on track when they comply again with our requirements. Our goal is to reduce our dependence on suppliers that are in trouble. We have been doing this for the past three years, and with good results. We have reduced the amount of purchasing from such suppliers from 15 percent to 3 percent of our sales.

Deiss: Our analysis of suppliers shows that over-aggressive acquisition strategies, unbalanced customer portfolios, high cost of raw materials and bad management often have led to financial problems. By the way, none of the financially distressed suppliers I have seen got into the situation because of OEM slashing prices. It has mainly been due to mistakes of the supplier’s management. The continuing high level of company insolvencies is a challenge. That is why we have decided to make risk management a central controlling instrument in purchasing. We are keeping a very close eye on developments in the suppliers’ economic situation. In the event of any supplier insolvency, we can take prompt measures to safeguard our production.Will the pace of low-cost country sourcing accelerate in the next few years?

Behrendt: For new markets, we are working closely with our existing and long-term supplier partners to develop local manufacturing footprints. However, where this may not be possible we have worked with local sources to fulfill local content requirements. In several cases, we have been able to facilitate partnerships between our global and local suppliers that have been beneficial for all parties.

Desforges: In order to keep our vehicles competitive in western Europe, we target a 40 percent low-cost country purchase ratio.

We have reached 30 percent so far. Outside of Europe, our target of low-cost country sourcing [we call it local integration] is 80 percent. We aim to reach 90 percent, provided the cost remains competitive. Today, our priority countries are Romania and eastern European countries because of proximity to our European bases, and China and India because of their competitive advantages.

The biggest limits we face today are to keep logistics and customs costs low enough not to offset the competitiveness of the low-cost country sourcing and to secure the quality level of the new suppliers located in emerging markets.

Adams: At Toyota we have seen a drift to the East to what I would call a more extended definition of Europe, which includes Turkey.

“Our focus is to always have more than one supplier so that we have a second option when needed,” said Gianni Coda, Fiat group chief purchasing officer.
Will more low-cost country sourcing mean many new suppliers -- or will you mostly buy from existing suppliers that move to the new markets?

Desforges: We want to keep having deals with our current partners as long as they continue to perform satisfactorily. About 70 percent of our local suppliers belong to global suppliers and 15 percent are independent suppliers that have deals with global suppliers. The rest are fully independent, but only provide us with components of low technical content.

Deiss: Our key low-cost country markets are eastern Europe and Mexico because of their proximity to our production facilities in Germany and the US. China and India also are creating well-developed supply bases. In general, we want to further unlock the potential of low-cost countries, but traditional suppliers still are the key for us to secure our access to technology and innovation.

No matter where the supplier is located, Daimler expects world-class performance in quality, cost, technology and logistics.

Adams: Sourcing from low-cost areas such as India, China, North Africa has happened little by little at the second and third tier level under the control of our first tier suppliers.How can purchasing contribute to getting new technologies into cars faster?

Behrendt: Early supplier involvement is the key to reduce time to market. Our Aligned Business Framework creates the foundation to access our suppliers’ newest technologies more readily and to get it to the market quicker.

Desforges: Renault’s engineering teams have been able to save time on the design of a car. The new third-generation Laguna was developed in 36 months. The Laguna 1 required 54 months. Our suppliers play a major role in getting new technologies into cars, as they are involved very early in the upstream developments.

Coda: Purchasing can contribute to getting new technologies into cars faster improving long-term partnerships with suppliers.

A long-term perspective is a necessary condition for the partners to invest in new technologies.

Deiss: It is crucial to get the suppliers and their ideas involved very early now that technology is changing so rapidly. Within our corporate integrated innovation management process, purchasing acts as broker and facilitator between the supplier and our r&d unit.

We monitor the market and regularly hold top-level discussions with our top suppliers about new technologies and innovative ideas.

Adams: Purchasing acting alone can achieve little. We have to motivate and facilitate technically based cost reductions. That means working with our designers, collaborating with the supplier designers and then following that through into the manufacturing process to ensure that we find the efficiency in manufacture to support the implementation of the new technologies. Our role is to encourage suppliers in r&d collaboration earlier in the model program.

If we wait until we have to make sourcing decisions on a specific model, then the lead time to achieve true development work does not exist. We have to pull our activity forward to the concept stage. I think chief engineers and program leaders will be motivated to act more quickly if we combine new technology proposals with significant cost reduction.

“We want to further unlock the potential of low-cost countries,” said Frank W. Deiss, Mercedes-Benz Cars vice president of procurement.
Are material prices still a problem? Do you expect the problem to ease in 2008? Where are the top challenges?

Behrendt: We think commodity prices will still be an issue during 2008 and potentially soften by the beginning of 2009.

But you really have to be prepared for a number of different scenarios because the economical developments in 2008 are difficult to predict. Our ability to influence commodity pricing at a macro level is limited. What we continue to focus on -- jointly with our suppliers -- is usage, weight, specifications etc.

Desforges: Raw materials prices have gone up sharply, and it appears to be a long-term trend. We still forecast raw materials price increase in 2008.

We have taken a large part of the extra cost on raw materials but in parallel, our suppliers were asked to make their best efforts to reduce their other costs.

Coda: Material prices are expected to be high in the medium term for steel products but softer for non-ferrous metal products.

Current oil prices could have some effect on the plastic products.

Deiss: Rising costs for raw materials will remain a challenge even if some commodities stabilize. Whenever it is possible, we enter into long-term contracts with steel suppliers. This improves planning reliability for Daimler and for our suppliers.

Together with our suppliers, we have to continue to find ways to raise efficiencies elsewhere.

Adams: In 2008 we are going to see concerns in the plastics area because of the high oil price. We are pretty well locked into the specific plastics grades that we use.

The other area is in steel, and the automotive grades of steel that we use are rather specific and therefore non-substitutable in nature. What we have to do is work through these problems with our suppliers.What implications does the weakness of the dollar have for your purchasing operations? Are you trying to get a better balance of currencies in your purchasing?

Behrendt: Chasing exchange rates is something you have to avoid. Exchange rates are not the main driver [for regional sourcing].

What is a driver is -- apart from the manufacturing capability and quality -- the real cost structure in any country or region.

Desforges: Renault purchases in the dollar area amount to less than the equivalent of €1 billion, mainly in raw materials.

The weak dollar has offset the raw materials price increase.

Coda: The weakness of the US dollar has little influences on our purchasing strategy.

Our Italian operations mostly buy in euros and the supply base of the other operations in the world is mainly local.

Deiss: Currency exposure is a permanent issue. In the procurement area, we support the company strategy of natural hedging by optimizing our global purchasing strategies.

“Cutting costs is not our sole objective. We want quality and delivery lead time to improve,” said Odile Desforges, Renault senior vice president of purchasing.
Is supplier consolidation a problem for you? Do you have a broad enough pool of well-qualified suppliers for all components? Where are their problems?

Behrendt: On key strategic commodities, we are working very closely and much longer term with fewer suppliers. This allows for open communication on our future plans, global scale and therefore more effective and longer term, optimized investment by our supply base.

Desforges: We pay attention to keeping the competition open within our supplier panel.

Coda: We are trying to avoid excessive reliance on a few big suppliers but the commercial relationship with some large groups is unavoidable.

We need to maintain these relationships but our focus is to always have more than one supplier so that we have a second option when needed.

Deiss: On one hand, there are commodity groups where we definitely need more competition as you find rather monopolistic structures within the supply base.

On the other hand, looking at the standardization and modularization that we are currently accelerating for certain commodity groups, there will be a potential to reduce the supply base. The situation has to be judged differently for each commodity.

Adams: In the past 12 months, more than in any other previous 12 months, we have seen evidence of financial distress in the supply base and we have had a small number of our independent European suppliers fall into financial administration procedures. We obviously aim to do sustainable business with our supplier base and that is the prime aim of working in an open book, costs-visible basis with the suppliers. However, despite our efforts, factors outside our control have led to financial distress in some cases.

What we need to do is to strengthen our risk management measures in terms of how we organize our response and resources in the event that the worst happens.

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